Risk Management

Islamic Financial System

The Islamic financial system, which is based on the principle of interest-free transactions, risk-sharing partnerships and altruistic donations, is central to the financial practices of several million Muslims throughout the world.

Islamic finance is much like traditional finance except that the services and products it creates conform to Islamic teachings, also known as sharia. The most well known of these is the prohibition against charging interest, known as riba in Arabic and a term whose explicit meaning is in dispute (more on that below).

Murabaha

Anyone who’s ever used a credit card knows you can’t borrow a dime without paying interest, but in Islamic finance, banks must find other ways to make money off their loans and other products. They usually do this by charging a service fee and/or engaging in profit-and-loss-sharing contracts. The most popular of such methods for home financing, for example, is called Murabaha, which is similar to rent-to-own schemes. A bank purchases a house for a customer and then sells it back at an agreed-upon markup.

Islamic finance is surging across the globe, gobbling up an ever increasing share of the more than $220 trillion in international assets outstanding. It’s a trend that has accelerated since the 2008 crisis shook confidence in conventional banking, prompting most of the world’s financial capitals from London to Dubai to join the battle to dominate the industry.

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